_Sudden stop creates watershed moment for the RBA
Until recently, the term sudden stop was reserved for emerging market economies. Until recently, it referred to an abrupt cessation of private sector capital inflows that required a rapid and painful adjustment away from reliance on overseas borrowings to restore a current account surplus. The Asian Financial Crisis of 1997-98 is a classic case, and Argentina has experienced more than its share over the years.
But the coronavirus pandemic is redefining the term and granting it a broader remit. We are in the midst of an economic sudden stop, the likes of which we have never seen before. Until recently, the Australian economy was on a solid growth path. After a soft patch during late 2018 and into the first half of last year, data for the second half of 2019 showed meaningful improvement with declining unemployment seemingly resuming a downward trend.
The pandemic has thrown that improvement out the window and cast Australia and the wider world into a new type of recession. Previous recessions of the 70s, 80s and 90s were typically the result of financial excess, high inflation and misjudged policy responses designed to tame them. And the Global Financial Crisis, while not resulting in a technical recession in Australia, also had its root causes in excessive risk taking and high leverage through the financial system.
This time is clearly different. The pandemic has required the introduction of extensive restrictions on movement and consequently on production that constitute a direct economic shock that is simultaneously reducing supply capacity and the willingness and ability of business and households to spend. In Australia’s services-based economy, output is highly dependent on the constant interaction of people and teams, and so the multitude of measures designed to slow the spread of the virus will inevitably lead to a large contraction in Q1 and Q2. This experience is being shared in all major economies around the world, with a global recession the result.
All of this means that the economic outlook is highly uncertain and with risks skewed to the downside. Principal among these is the risk that credit conditions turn for the worst, with doubts about households’ and business’ ability to service debt resulting in more stringent terms that creates a negative feedback loop further weakening the economy.
Seen in this light, the strong and immediate actions of the RBA to shore up the supply and price of credit have been critical interventions that significantly reduce these risks. A $90 billion line of credit to the banks aimed at supporting business lending provides a substantial backstop of liquidity. Likewise, their actions to reduce the overnight rate to 0.25% and enter the realm of quantitative easing by setting an equivalent target of 0.25% for the three year bond yield will effectively cap the price of credit at levels that would have been considered unthinkable a year ago.
In this, they have framed their response reflecting other ways in which this time is different. With inflation dormant, having been persistently below target for almost six years, they have been free to act without fear of a CPI surge. And in undertaking QE they have also acted differently out of necessity. With substantial stimulus required, and the cash rate already at its effective lower bound of 0.25%, they have needed to use alternative means, opting for a target on the three year bond yield to exert downward pressure on rates right along the maturity spectrum.
These actions will entrench them alongside other global central banks as key drivers of pricing at the longer end of the yield curve. They change the relationship between fiscal and monetary policy, with the RBA now active in the secondary market for government bonds. And they also significantly extend their influence on financial markets through direct intervention in the market for longer dated assets.
Australia is the latest of a series of countries to witness this expansion of central bank actions. Globally, the interventions and their effects have proved long lasting, and they will impact Australian property for years to come.
For further information please contact:
Ben Burston
Partner, Chief Economist
+61 2 9036 6756
Ben.Burston@au.knightfrank.com